Erik R. Sirri, Director, Division of Trading and Markets, SEC, spoke at the SIFMA Market Structure Conference 2008, on May 9, 2008, on Maximizing Liquidity in the U.S. Equity Markets. He focused on the key characteristics of the post-Reg NMS equity market structure, the issue of best execution for a customer's non-marketable limit orders, and the role of the regulator.

The SEC obtained emergency relief in response to its complaint, filed May 5, 2008, that Gregory N. McKnight (McKnight) and Legisi Holdings, LLC (Legisi Holdings) conducted a fraudulent, unregistered offering of securities in which, between December 2005 and at least November 2007, they raised approximately $72 million from more than 3,000 investors in all 50 states and several foreign countries through the Legisi website. According to the SEC's complaint, McKnight represented that he would invest the offering proceeds in foreign currencies, commodity futures, stocks and real estate and promised to pay interest of as much as 15 percent per month from the profits from his investments. The SEC's complaint further alleges that throughout the period of the offering, McKnight represented to investors that his investments were profitable and were generating the promised returns. The complaint charges that, contrary to these representations, McKnight invested only approximately $33 million of the offering proceeds and that, rather than earning profits, these investments resulted in millions of dollars in losses. The SEC's complaint further charges that Defendants used approximately $27.5 million of the offering proceeds to make payments of purported profits to prior investors and were, thus, operating a Ponzi scheme, and that McKnight used $2.2 million of investor funds to pay for his personal expenses and to make payments to his relatives, Jennifer McKnight, Danielle Burton, and Theresa Burton.

On May 5, 2008, the United Stated District Court for the Eastern District of Michigan issued an Asset Freeze Order against the defendants, and against Legisi Marketing, Inc. (Legisi Marketing), Lido Consulting, LLC (Lido Consulting), Healthy Body Nutraceuticals (HBN), and Lindenwood Enterprises, LLC (Lindenwood) as relief defendants. The Asset Freeze Order froze all assets of McKnight, Legisi Holdings, Legisi Marketing, Lido Consulting, HBN, and Lindenwood. In addition, Judge Gadola issued an Order Appointing a Receiver over all assets of McKnight, Legisi Holdings, Legisi Marketing, Lido Consulting, HBN, and Lindenwood.

In addition to the emergency relief already obtained, the Complaint seeks preliminary and permanent injunctions against McKnight and Legisi Holdings. The Complaint also seeks disgorgement of ill-gotten gains from the defendants and relief defendants and the imposition of civil penalties against McKnight and Legisi Holdings.

In recent years FINRA has narrowed the definition of "public arbitrator" to reduce the connections of the non-industry arbitrator to the securities industry. Effective June 9, 2008, FINRA will add an annual revenue limitation to the definition of public arbitrator, set forth in the Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes. The amendment, which was approved by the Securities and Exchange Commission, seeks to ensure that individuals with ties to the securities industry may not serve as public arbitrators in FINRA arbitrations

SEC Chair Cox's response to the Bear Stearns collapse -- and perhaps to the Treasury Dept's Blueprint that calls for a diminishment of the SEC's role -- is to call for greater agency oversight over the four remaining "consolidated supervised entities" -- Morgan Stanley, Goldman Sachs, Lehman and Merrill Lynch --- those giant financial firms that do not have a bank that subjects them to Federal Reserve supervision. In recent speeches Cox has called for more disclosure about capital and liquidity and a reduction of short-term financing. Todays Wall St. Journal's Heard on the Street column questions whether additional disclosure about capital and liquidity would be useful to investors. Reducing firms' leverage might be useful, although Wall St. will complain that the SEC is turning "pit bulls into poodles." That might be a good thing. WSJ, The SEC's Show of Force.

UBS concluded an investigation by the Massachusetts Attorney General and agreed to return $35 million to Massachusetts municipalities that bought auction rate securities for short-term cash needs and were unable to sell them later when the auction market dried up. UBS said that ARSs had not been permissible for the municipalities to buy, adding that "The reasons supporting this agreement apply only to the circumstances of this specific case under Massachusetts law." WSJ, UBS to Return Investor Funds.

On May 6, the SEC proposed amendments to the rules applicable to cross-border tender and exchange offers and other kinds of cross-border business combination transactions. The rule changes are intended to protect U.S. investors while facilitating and streamlining cross-border transactions, as securities markets become increasingly globalized. The Commission also proposed changes to the beneficial ownership reporting requirements for certain foreign institutional investors. If adopted, these rule revisions would allow some foreign institutions to file beneficial ownership reports on a shorter form, under the same circumstances as their U.S. institutional counterparts. In addition, the Commission issued guidance on several cross-border issues, including the exclusion of foreign target security holders from a tender offer subject to U.S. equal treatment requirements, the exclusion of U.S. target security holders in cross-border business combination transactions, and the use of certain transaction structures to provide cash to U.S. target security holders in cross-border exchange offers.

The SEC explained that

after eight years of experience with the current cross-border exemptions adopted in 1999, the Commission is proposing changes to expand and enhance the utility of these exemptions for business combination transactions. Our goal continues to be to encourage offerors and issuers in cross-border business combinations, and rights offerings by foreign private issuers, to permit U.S. security holders to participate in these transactions in the same manner as other holders. Many of the rule changes we propose today would codify existing interpretive positions and exemptive orders in the cross-border area. In several instances, we request comment about whether the rule changes we propose also should apply to tender offers for U.S. companies. In this release, we also address certain interpretive issues of concern for U.S. and other offerors engaged in cross-border business combinations. We hope that this guidance will prove useful in structuring and facilitating these transactions in a manner consistent with U.S. investor protection.

The SEC settled charges against Marvell Technology Group, Ltd., a Silicon Valley semiconductor company, and its co-founder for improperly backdating stock option grants to employees. The agency alleged that Marvell provided potentially lucrative "in-the-money" options to employees, backdated the options to dates with lower stock prices, and falsely represented that the options had been granted "at-the-money" on earlier dates. According to the SEC's complaint, filed in federal district court in San Jose, the scheme allowed Marvell to overstate its income by $362 million from its fiscal years 2000 through 2006.

Marvell and former operating officer Dai settled the SEC's charges without admitting or denying the allegations and will pay financial penalties of $10 million and $500,000, respectively.

FINRA fined GunnAllen Financial, Inc., of Tampa, FL $750,000 for its role in a trade allocation scheme conducted by the firm's former head trader, as well as for various Anti-Money Laundering (AML), reporting, record-keeping and supervisory deficiencies. Kelley McMahon, the former head trader's supervisor, was suspended for six months from association with any FINRA-registered firm in any principal capacity and fined $25,000, jointly and severally with the firm. FINRA barred Alexis J. Rivera, the former head trader, in connection with the trade allocation scheme, in December 2006. FINRA found that in 2002 and 2003, the firm, acting through Rivera, engaged in a "cherry picking" scheme in which Rivera allocated profitable stock trades to his wife's personal account instead of to the accounts of firm customers. Rivera garnered improper profits of more than $270,000 through this misconduct.

In connection with the firm's investment banking business, FINRA found that prior to March 2005, GunnAllen never put any stock of a company on a restricted or watch list even though the firm was conducting investment banking business with these companies. During the same period, GunnAllen failed to inform its own compliance department of the investment banking activities in which the firm was involved. FINRA also sanctioned GunnAllen for failing to report to FINRA that its parent firm had entered into a consulting contract with an individual who had been previously barred by FINRA. In addition, the firm was sanctioned for failing to preserve e-mails and instant messages, for failing to implement an adequate AML compliance program and for supervisory and complaint reporting deficiencies. GunnAllen and McMahon settled these matters without admitting or denying the allegations, but consented to the entry of FINRA's findings

Merrill CEO John Thain said yesterday that the company has $44 billion of equity capital, an all-time high, and that it does not need to raise any more. He also stated that he expects Merrill's clients' auction-rate securities to be fully refinanced by their issuers within a year. WSJ, Merrill's Thain Backs Auction-Rate Securities.

In recent speeches, SEC Chair Cox has emphasized the regulatory gap in the supervision of investment banks after Gramm-Leach-Bliley, where there is no mandatory consolidated supervision for four of the major linvestment banks -- Goldman Sachs, Lehman, Merrill Lynch and Morgan Stanley. To date the SEC has filled the gap with its voluntary Consolidated Supervisory Entity (CSE) program. Specifically, he has emphasized that the law does not require investment bank holding companies to compute capital and maintain liquidity on a consolidated or for a consolidated supervisor that is knowledgeable in the securities business. Cox also said that investment banks must disclose capital and liquidity positions in a way that investors can understand. Did the Chair's statements rattle the market yesterday? NYTimes, A Plunge Disrupts the Recent Calm; WSJ, SEC Ramps Up Street's Disclosure.

BlackRock, the largest publicly traded asset management firm, is making big bucks in the troubled credit markets, currently responsible for managing $30 billion of hard-to-sell assets of Bear Stearns and another $22 billion from UBS. Laurence D. Fink, BlackRock's CEO, began his career over 20 years ago at First Boston, working on mortgage bonds. While Rep. Henry Waxman, head of the House Oversight Committee, has questioned the New York Federal Reserve about BlackRock's selection to manage the Bear assets without a competitive bidding process, others defend it because of the need to move swiftly upon Bear Stearn's collapse. NYTimes, BlackRock Is Fix-It Firm to Manage Risky Assets of Others in Distress.

SEC Chair Cox Testified on the agency's Fiscal Year 2009 Appropriations Request Before the Subcommittee on Financial Services and General Government Committee on Appropriations, United States Senate, May 7, 2008.

And yet here, the framework of federal financial services regulation as it was developed throughout the 20th and 21st centuries is dangerously behind the times.

Today, no regulator in the federal government is given explicit authority and responsibility for the supervision of investment bank holding companies with bank affiliates. Under the statutory scheme that the Congress devised, most recently in the Gramm-Leach-Bliley Act, there is mandatory consolidated supervision by the Federal Reserve for commercial bank holding companies, including financial holding companies. For investment banks that do not have U.S. banks within the consolidated group, the law provides for a holding company supervision structure that is purely voluntary — and only one investment bank, Lazard Ltd., has volunteered for this supervision. The four largest investment bank holding companies in the U.S. are ineligible for it because they have specialized bank affiliates, such as industrial banks or certain savings banks....The notion embedded in the Gramm-Leach-Bliley Act that investment banks should be able to operate outside of a statutory consolidated supervision regime is no longer tenable in the wake of Bear Stearns. It is impossible for anyone to say that in this case, "the system worked." It is true that the statutory scheme produced all that it ever demanded — no customer cash or securities were ever at risk of loss because of the elaborate protections they enjoy under the SEC's existing regulation, including the segregation of customer funds and securities. But that limited purpose, which views the SEC's role and that of other financial regulators vis-a-vis the nation's largest investment banks as limited to protecting customer funds and securities in the regulated broker-dealer subsidiaries of firms such as Bear Stearns — is no longer enough.

The SEC's Division of Investment Management has prepared a recommendation for consideration by the Commission to increase the availability of capital to certain smaller companies that do not have ready access to the public capital markets or other forms of conventional financing. The Division has recommended that the Commission adopt an amendment to a rule that defines the types of companies in which business development companies (BDCs) may invest most of their assets. Congress in 1980 established BDCs, which are publicly traded investment companies, to help make capital more readily available to small developing and financially troubled businesses. The SEC's release explains that:

The Investment Company Act requires a BDC to have at least 70 percent of its portfolio invested in certain assets, including securities of "eligible portfolio companies," which are often small or developing businesses, at the time it makes any new investments. The proposed amendment would expand the definition of eligible portfolio company to include certain companies that list their securities on a national securities exchange.

The Investment Company Act defines eligible portfolio company to include a domestic operating company that, among other things, does not have any class of securities that are marginable under rules issued by the Federal Reserve Board. In 1998, for reasons unrelated to small business capital formation, the Federal Reserve Board amended its margin rules to include all publicly traded equity securities and most debt securities. These 1998 amendments had the unintended consequence of substantially reducing the number of companies that met the definition of eligible portfolio company.

In 2006, the Commission adopted new rules under the Investment Company Act to address the effect of the Federal Reserve Board's 1998 amendments on the definition of eligible portfolio company. The Commission adopted Rule 2a-46, which defines eligible portfolio company to include all private companies and public companies whose securities are not listed on a national securities exchange. The Commission also adopted a rule that conditionally permits a BDC to include in its 70 percent basket any follow on investments in a company that met the new definition of eligible portfolio company at the time of the BDC's initial investment in it.

When the Commission adopted Rule 2a-46, it also proposed to amend the rule to further expand the definition of eligible portfolio company to include certain smaller companies that list their securities on a national securities exchange. The amendment was designed to facilitate small business capital formation by providing added investment flexibility to BDCs, consistent with the purpose of the Investment Company Act. The Commission sought comment on three alternative ways to amend the rule, and received comments on the proposal.

The Division has submitted a recommendation that the Commission adopt an amendment to Rule 2a-46.

The SEC obtained a court order to stop a $27 million Ponzi scheme involving investors in the United States, Canada, and other countries. The agency charged Gold-Quest International and its three principals for the alleged misuse of investor funds in a scheme that promised incentives to investors who recruited "friends and family" into the system. The SEC alleged that Gold-Quest and its owners misrepresented that investor funds would be pooled and invested in foreign currency exchange trading and would generate annual profits of 87.5 percent. No investor money was actually invested in foreign currency exchange trading.

According to the SEC's complaint, Gold-Quest's owners David M. Greene (who refers to himself as Lord David Greene), John Jenkins, and Michael McGee instead used investor funds to compensate investors who brought in new investors. Up to 88 percent of each investor's principal was paid to the chain of promoters responsible for bringing the investor into the Gold-Quest program. Most of the remaining funds were used by Greene, Jenkins, and McGee for personal expenses.

The Federal District Court for the District of Nevada issued an order freezing assets and appointing a temporary receiver over Gold-Quest and its affiliates. According to the SEC's complaint, Gold-Quest and its owners claim they are not subject to the jurisdiction of the United States or Canada because they are members of the Little Shell Nation Indian tribe, purportedly headquartered in North Dakota. However, the Little Shell Nation is not in fact recognized as a sovereign tribe or nation.

In its lawsuit, the SEC obtained an order (1) freezing the assets of Greene, Jenkins, and McGee; (2) freezing and repatriating the assets of, and appointing a temporary receiver over, Gold-Quest and its affiliates; (3) preventing the destruction of documents; and (4) temporarily enjoining Gold-Quest, Greene, Jenkins, and McGee from future violations of the antifraud provisions of the federal securities laws.

Fannie Mae plans to raise another $6 billion through sales of common and preferred shares. It announced a first quarter loss of $2.19 billion ($2.57 per share) and plans to cut the dividend from 35 cents to 25 cents. WSJ, Fannie to Boost Capital After Posting Big Loss.

The United States District Court for the Northern District of Georgia entered a Final Judgment against Stinger Systems, Inc. (“Stinger”), enjoining it from future violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Stinger consented to the entry of the final judgment without admitting or denying any of the allegations of the Commission’s Complaint. The SEC alleged that from October 2004 through March 2005, Stinger and its president, Robert F. Gruder, made a series of fraudulent material misrepresentations and omissions regarding Stinger’s “flagship” stun gun product. According to the Complaint, the misrepresentations consisted of press releases and direct mailings to thousands of law enforcement officers and agencies, suggesting that Stinger was manufacturing, selling and shipping its stun gun. In fact, the product was still in the development phase. The Complaint further alleged that the misrepresentations consisted of statements on the Stinger’s website and/or in industry publications that indicated Stinger’s stock was trading on NASDAQ, when in fact it was not. The Complaint also alleged that Stinger and Gruder misrepresented that the Bureau of Alcohol, Tobacco and Firearms (“ATF”) certified Stinger’s stun gun, even though the ATF offered no such certification. According to the Complaint, these misrepresentations caused a spike in the trading volume and price for Stinger’s shares once it began publicly trading in November 2004.

The Wall St. Journal reports that President Bush will nominate Professor Troy Paredes, Washington University at St. Louis School of Law, to replace Paul Atkins on the SEC. If Professor Paredes and the two Democratic nominations (Luis Aguilar and Elisse Walter) are confirmed, the SEC will be back to its full five-member strength. Troy has written extensively in the area and is now co-author, with Joel Seligman, of the multi-volume treatise originally authored by Louis Loss. WSJ, Bush to Nominate Paredes to SEC.

A subcommittee of the Senate Banking Committee will hold a hearing tomorrow on the SEC's oversight of investment firms. The focus is likely to be the SEC's CSE (consolidated supervised entity) program that regulates the large firms from the holding company level down. SEC Chair Cox and Director of Trading and Markets Eric Sirri are expected to testify, as are former SEC Chairs David Ruder and Arthur Levitt. WSJ, SEC to Come Under Scrutiny.